11/29/20101MGMT 4370 / MGMT 7760Risk ManagementAparna GuptaLally School of Management and TechnologyOffice: PITTS 2104Email: [email protected]Phone: x2757Asset-Liability Managementanother arm of Risk Management2Aparna Gupta, Lally School, RPIAsset-Liability Management•ALM is the structured decision-making process for matching the mix of assets and liabilities on a firm’s balance sheet. The objectives are:1.Stabilize the net interest income •NII: difference between the amount the bank pays out in interest for funding and the amount it receives from holding assets, such as, loans.2.Maximize the net worth•NW: long-term economic earnings.3.Make sure the banks doesn’t assume too much risk from the mismatching of maturities and amounts between assets and liabilities and from funding liquidity risk•Funding liquidity risk: the danger that the bank will not be able to raise funds quickly and cheaply enough to fulfill it obligations and remain solvent.3Aparna Gupta, Lally School, RPIAsset-Liability Management•The wide scope of ALM can include managing –market risk (interest rate, for-ex, commodity, equity price risks), –liquidity risk, –trading risk, –funding and capital planning, and –regulatory constraints, as well as profitability and growth. •VaR technique controls market and credit risk in the trading books, •ALM uses distinct techniques to control risk in the banking books. –Techniques include –gap analysis, duration gap analysis, long-term VaR.•ALM is particularly critical for financial institutions–commercial banks, –savings and loans, –insurance companies and –pension funds.4Aparna Gupta, Lally School, RPIAsset-Liability Management•For instance, banks engage in collecting deposits and extending loans to retail and corporate clients. •This financial intermediation activity can generate two types of imbalances:–Imbalance between the amounts of fundscollected and lent.Ib lb tthtitilli ttt–Imbalance between the maturities as well as interest rate sensitivitiesof the sources of funding and the loans extended to clients.•These imbalances drive the net worth (NW) of the bank.–And can cause serious problems of insolvency if not managed.5Aparna Gupta, Lally School, RPIAsset-Liability Management•For example:•In a bank, deposits generally have a shorter maturity than loans–The net worth of many banks benefits from a fallin interest rates. –Conversely, the net worth of the banks deterioratesif interest rates go up. •If this downside risk is not managed, it can lead to insolvency in individual institutions or even in the whole banking industries.individual institutions or even in the whole banking industries.

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